Opinion – Paul Krugman: Reviewing the summer of stagflation


I don’t know if there will be any surprises in the State of the Union address. I know that the background to the speech will be very different from what the vast majority of experts expected a few months ago.

After all, by now, Joe Biden’s presidency should be effectively over — his political club destroyed by a devastating Republican wave in the midterm elections, his political credibility eviscerated by a recession and high inflation.

Well, the red wave was more of a ripple. And recent economic numbers have been surprisingly favorable. Half a million jobs were created last month, bringing total job creation under Biden to 12 million so far, with the unemployment rate falling to 3.4%, its lowest level since 1969. Inflation was high in 2021 and part of 2022, but has dropped since then; over the last six months, consumer prices have risen at an annual rate below 2%.

If the economic news sounds too good to be true, that’s probably because it is. Most experts I talk to think January’s giant employment report was a statistical anomaly. The inflation numbers reflect several temporary factors, although they go in both directions; I won’t be surprised if inflation picks up a bit in the coming months, but that’s not a certainty.

What is clear, however, is that until a few months ago, many, if not most, economic forecasts were very negative about the prospects for the United States. In particular, we went through what I think of as the summer of stagflation – a period, actually extending somewhat into the autumn, when many influential economists made extremely somber pronouncements about what it would take to rein in inflation.

And I think it’s important to ask why they were so wrong.

Now, show me an economist who hasn’t made any incorrect predictions, and I’ll show you one who doesn’t take enough intellectual risks. I’ve made a lot of bad bets over the years; in particular, I did not expect inflation to rise the way it did.

That said, I’ve been reviewing the most influential of these pessimistic reviews and it’s surprising how dismal they were compared to what actually happened. Most famously, last June, Larry Summers declared – with commendable specificity – that containing inflation would require five years of 6% unemployment, two years of 7.5% unemployment, or one year of 10% unemployment.

Another influential paper, presented at the Brookings Institution in September, also predicted that inflation would remain very high unless there was a large increase in unemployment.

To be fair, inflation may not yet be fully under control. But it fell enough, without any rise in unemployment, to make it clear that such forecasts were overly pessimistic. So why did people believe them?

Not everyone on Team Stagflation used the same approach. But much, if not all, of the pessimism rested on the assumption that the 2021-22 inflation was exactly like that of the 1970s, which was actually only contained through a long period of very high unemployment.

The thing is, there were always good reasons to believe that this analogy was a bad one. Economists who almost got it right, like Joseph Gagnon of the Peterson Institute, argued early on that the Korean War — which produced a sharp but short-lived spike in inflation — was a better model than the 1970s for what was happening. I and others have pointed out that disinflation was difficult in the 1980s mainly because expectations of persistent inflation had taken hold, which this time clearly had not.

Why, then, did economists make dire predictions so confidently, and why did so many others – especially in the news media – accept them? We’re not talking about intellectual dishonesty: the inflation pessimists have been remarkably clear about their data and assumptions. But there was and is a mentality – arguably affecting the economists themselves, definitely affecting much of their public – that is always ready to see any economic setback as a repeat of that 1970s show, which always sees stagflation lurking in the loom.

This mentality is not explicitly political; I’m not talking about the Heritage Foundation guys who spent much of last year proclaiming a Biden recession and will never, ever apologize.

But, I think, it reflects the desire to see the economy as a morality act, in which policymakers’ attempts to make things better are severely punished (whereas doing too little is not). The Biden administration’s initial spending package was larger than it should have been; the Federal Reserve was slow to realize how much inflation was rising. Surely such sins must attract terrible retribution from the gods of macroeconomics!

But they didn’t. So will the prophets of calamitous inflation admit they were wrong? More importantly, will policymakers, especially at the Fed, who underestimated inflation risks in 2021, be flexible enough to accept that they overcompensated in 2022? Because if they don’t, the policy response to imaginary stagflation could still produce an unnecessary recession.

Translated by Luiz Roberto M. Gonçalves

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